The dice are rolling on Dell’s legacy

Dell founder Michael Dell has much to ponder as he awaits to see if his buyout gets shareholder approval
AP

by
Jeff Sommer

In 1984; the year Mark Zuckerberg, the Facebook creator, was born; Michael Dell started a tech company in his dorm room, dropped out of college and changed the world.

By making personal computers that were powerful, reliable and inexpensive, and by selling directly to buyers who customised their PC features, Dell revolutionised his industry.

“The original PC industry was long on people with great technical ideas but short on people who were able to turn those ideas into opportunities ; into products that people really wanted," said Timothy Bresnahan, a Stanford economist. Along with Steve Jobs and Bill Gates, as well as Scott Cook of Intuit, Dell was one of those few great innovators, he said. “These people are very rare."

Dell’s early achievements were formidable, but unless his latest effort to turn around his company is successful, the Dell legacy today is very much in doubt. Last week, along with Silver Lake Partners, a private equity firm, he made a $US24.4 billion buyout offer for his company ; an apparent bet that, without the scrutiny of public shareholders, he can get Dell back on track.

Dell, the company, has been losing ground for years as the industry it once dominated has undergone upheavals that its founder failed to foresee. “The very nature of technology is that it changes a lot," said Toni Sacconaghi, an analyst at Sanford C. Bernstein. “And Michael has conceded publicly that he has missed some big changes ; he failed to foresee smartphones or tablets ; and both of these shifts have been highly detrimental to the PC world."

He has lagged in a crucial area of corporate strategy as well, said Shaw Wu, an analyst at Sterne Agee in San Francisco. While Dell has always been attuned to the needs of corporate clients, he is 20 years behind IBM in embracing a strategic shift to enterprise software and services, Wu said: “That’s a higher-margin business that Dell would like to go after, but IBM and others have got tremendous leads. It will be very difficult for him to catch up."

If Dell shareholders accept an offer price of $US13.65 a share, Dell, who is contributing his stake of more than 14 per cent in the company plus hundreds of millions more, would end up with more than 50 per cent of the new company’s equity, Sacconaghi estimated. Dell, who declined to comment for this article, would control the company without being subject to the day-to-day pressures of the stock market, which has pummeled Dell shares because its earnings have weakened.

While Dell reports that 50 per cent of its revenue is directly related to PCs, Wu says the figure is 70 to 80 per cent when indirect revenue, like that for computer monitors, printers and services, is included. “The company has made big investments in other areas, but it’s still mainly a PC company," he said.

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That’s a big problem for several reasons. Once considered the low-cost provider in the field, Dell now faces lean Asian competitors like Lenovo, Asus and Acer that make PCs more cheaply and accept lower profit margins. Yet these companies, particularly Lenovo, have also garnered praise for making excellent computers, not merely well-priced ones. At the same time, Dell’s vaunted reputation for quality and service has waned.

Lenovo, which makes the ThinkPad line of notebook computers formerly sold by IBM, “has been picking up corporate customers from Dell," Wu said.

Then there is a deeper issue: the entire PC industry is stagnant at best. Worldwide PC shipments declined 4.9 per cent in the fourth quarter, versus the year-earlier period, according to Gartner, a market research firm. Consumer preferences are shifting. With the ubiquity of smartphones and tablets ; segments where Dell is absent or very weak ; consumers aren’t replacing PCs as often.

“We don’t expect people to abandon PCs, but they won’t rely on them as much in the future," said Mikako Kitagawa, a Gartner analyst. Dell’s share of this no-growth market has been shrinking, to 10.2 per cent worldwide in the fourth quarter of 2012, from 12.2 per cent the previous year, Gartner said.

Facing such headwinds, Sacconaghi said, Dell hopes to “hold PC profits flat or, worst case, down 5 per cent a year, while they grow the rest of the business to more than offset that." But the market is skeptical. Dell’s shares fell 30 per cent in the 12 months before January 14, when reports of an imminent buyout appeared.

The leveraged buyout will layer $US15 billion of new debt on the company. Microsoft, with which Dell has had close ties, is providing $US2 billion. Because interest rates are extraordinarily low, servicing all that debt should be manageable, assuming that Dell maintains its current cash flow, Sacconaghi said.

It’s not clear how much the debt load will constrain Dell’s investments in research and development. Josh Lerner, a Harvard Business School professor, said a study for which he was a co-author found that after leveraged buyouts, most companies maintained their ability to innovate, largely by focusing research in “their core competencies."

In other words, he said, “Dell might be able to prosper after a buyout; it would depend on how Michael Dell manages the company."

Is the price being offered for the company fair? It’s often unwise to bet against company insiders, especially founders like Dell, who may be presumed to know their companies’ value better than outside investors.

Consider John W. Kluge, who took Metromedia private in 1984 in a $US1.1 billion leveraged buyout. Kluge, Metromedia’s founder, promptly liquidated it, selling television stations (to Rupert Murdoch) and sundry assets like the Harlem Globetrotters and the Ice Capades. In the end, Kluge tripled his take ; to the chagrin of many former shareholders.

Kluge, who died in 2010, wasn’t interested in preserving his company or revolutionising an industry, however. He merely wanted to make money. “When we buy an asset, we look at it as a return on the investment," he said in 1980.

For Dell, whose name is on the door, other factors may be in play. “Another chapter is still to be written," Bresnahan said. Money will be part of it. So will the Dell legacy.